The Telecom Exploits Of Iliad

The upstart has brought lower rates and new services to France -- and the Continent

Xavier Niel never imagined France would owe him such a debt of gratitude. Back in 1999, when he launched a free Internet service appropriately named, his goal was only to challenge rivals such as AOL and Wanadoo in Net access. Six years later, Free, a unit of Iliad Group, has carved a wide swath through France's telecom landscape, spurring regulators to open the market faster to competition and prodding the former state-owned monopoly, France Telecom (FTE ), to respond with aggressive price cuts and new services. "Free brought competition to the French market," says Roland Montagne, head of broadband research for telecom watcher IDATE in Montpellier.

And how. Once a laggard in mobile and Internet penetration, France now leads Europe in the use of cutting-edge Voice-over-Internet Protocol, or VoIP, technology. Some 8% of French households and businesses make VoIP calls, vs. less than 1% in usually progressive Britain and about 3% in the U.S. That's thanks mostly to Free, which launched DSL broadband service in October, 2002, and now counts more than 1.45 million subscribers as of the end of September -- some 90% of which make VoIP calls via DSL.

Spurred into action, France Telecom became the first major telecom company in Europe to roll out its own residential VoIP service in June, 2004. It has since signed up a half-million users. "Free has helped drive France Telecom to be more innovative," says Jean-Charles Doineau, research director in the Paris office of telecom consultancy Ovum. Although France Telecom's fixed-line revenues fell 3.5% year-over-year in the third quarter, the damage would have been far worse were it not for the booming broadband, VoIP, and TV-over-DSL offerings unveiled in recent years.

Iliad operates only in France, but its impact is being felt across the Continent. Industry watchers have warned for years that the move to mobile phones and competition from new operators would slam fixed-line voice revenues. But nobody anticipated how fast VoIP would catch on once consumers embraced broadband. "France is clearly ahead in VoIP," said France Telecom Chief Financial Officer Michel Combes in an Oct. 27 investor call. "But you will see this [revenue crunch] starting to happen to our peers, too." Indeed, on Nov. 3, Deutsche Telekom (DT ) revealed the troubles facing its fixed-line unit: Falling revenues are prompting the company to slash 32,000 workers, one-fifth of the unit's employees, over the next three years. Other telcos, such as Belgium's Belgacom, have since announced layoffs of their own, in part because of revenue losses brought on by the move to VoIP.


From the beginning, Iliad was fast and clever. The gimmick of free service -- made possible by a clause in French regulations that requires France Telecom to share connection revenues with companies whose services transit its lines -- quickly made Free the country's No. 2 Net service provider, behind Wanadoo. When Iliad first launched its DSL service in 2002, it used lines wholesaled from France Telecom. The upstart's long-term goal, though, was to operate its own network. With cash flow from the ISP and broadband businesses, plus $111 million raised in a January, 2004, initial public offering, Iliad leased fiber-optic lines, bought up bankrupt rivals, and installed its own gear in hundreds of France Telecom switching centers. Some 69% of its customers are now on Iliad's own network.

Iliad has also stuck with a hard-and-fast pricing strategy. Rather than getting into suicidal price wars with rivals, it has held its rate steady at 29.99 euros ($35) per month, while constantly adding services. Three years ago, the monthly charge bought customers a sluggish 512 kilobit-per-second DSL connection. Now, for the same price, they get a superfast 24 megabits per second (vs. the 1 to 6 megabits per second that is the norm in the U.S.), plus free phone calls anywhere in France, 80 channels of free digital television, and 20 Internet radio stations. "We always saw this as an industry based on services, not just price," says Iliad Chief Financial Officer Olivier Rosenfeld. Brokerage JPMorgan (JPM ) figures Iliad will earn net profits of $136 million this year, a 90% increase on 2004, on revenues of $767 million.

The investment in its own network is paying off big for Iliad. Because the wholesale rates France Telecom charges Free to use its DSL network are so high, the 31% of Free customers still being served via those lines produce no profits. But users on Iliad's own lines yield gross margins of more than 80%. The company aims to bring 84% of subscribers onto those lines by 2009. At the same time, Iliad's average monthly revenues per user are actually growing -- topping $40 in the third quarter -- as customers sign up for extra TV channels and make paid calls to mobile phones or numbers outside France. Rivals playing the price game, meanwhile, face shrinking margins and static market share.

Iliad has defied convention in other ways. Eschewing outsourcing, it designed its own hardware -- the residential "Freebox" that powers its Net, voice, and TV services -- and even manufactures the gizmo in French factories. Perhaps most remarkably, the company, which now counts 1,000 employees, runs its own 850-person call center in the heart of Paris. Why not send the work to Spain or Poland? "It's about control, quality, and customer intimacy," says Rosenfeld.

Investors are enchanted with Iliad's story. Its shares have more than doubled in the last 12 months and are up 63% since the start of 2005, to $52.87 on the Paris bourse. Niel's 67% stake makes him a rare French tech billionaire. But his wealth pales compared to the billions he has saved French consumers by driving down telecom rates and speeding broadband services to market. That's a career achievement few French entrepreneurs can put on their résumés.

By Andy Reinhardt

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